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ESOP makes changing of the guard profitable for all

Posted on August 3rd, 2017

Written by: Christine Fisher | Produced by: Ian Nichols

When John W. “Jack” Somerville sold his architecture and engineering firm, Somerville Inc., he wanted to preserve the reputation his family had built over 50 years. He wanted to avoid selling to a large firm that might gut Somerville Inc. of its legacy or its longtime employees. Converting the firm to an ESOP, or employee stock ownership plan, was an appealing way to do just that.

Then, when the Recession hit in 2008, the ESOP had already been in place for a decade. At a time when Somerville Inc.’s competitors were closing or downsizing, the firm was able to keep its doors open and its workforce intact. The ESOP provided a kind of weatherproofing.

Now, as fewer students enter the architecture and building-related engineering fields, the ESOP structure helps with employee recruitment and retention, too. Thanks to the ESOP, employees earn more when the business does better. Some equate it to owning a home versus renting, according to the firm. Having “skin in the game” pushes employees to be more engaged, efficient and effective.

ESOP turns skeptics into believers

In 1946, Jack’s father, John E. Somerville, founded the firm with just three employees. Fifty years later, in 1997, his son, Jack, became president and began to consider how he might sell the firm so he could retire at the end of 2006.

By that point, Somerville Inc. had grown into a full-service architecture and engineering firm in Green Bay, Wisconsin. Its longtime clients included big names like Bellin Health, a major regional healthcare provider, and theGreen Bay Packers—both clients of the firm since the 1950s—as well as Tyco, a fire protection and security company and a client since 1946.

In 1999, it was decided that Somerville Inc. would convert to an ESOP, so that Jack could turn the company over to his employees, thereby sustaining the firm and keeping the family name associated with it, says Michael Kadow, who’s served as Somerville Inc.’s president since 2006.

Converting to an ESOP meant employees had to purchase the firm’s stock. That was no small feat, financially and otherwise, for a firm of Somerville Inc.’s size. So, the employees created an ESOP trust, which needed to borrow the money necessary to purchase Somerville’s stock. This was done in two phases over nine years. After the transactions were complete, a few minority shareholders remained. The ESOP purchased those shares as well, and in 2008, Somerville Inc. became 100 percent employee-owned.

“Early on, when the ESOP had a debt to pay off and the equity wasn’t significant, I don’t think employees thought much of it,” Kadow says. “They thought, well this is just a way for the owner to get his money out of the firm; what’s in it for me?” But as their stock certificates began to grow each year, they started to come around. “The skepticism turned into belief and then the believers turned to action and the action has improved our firm and all the various touch points we have with our clients,” Kadow says.

After Recession, ESOP boosts retention

Today, Somerville Inc. is both 100 percent employee-owned and an S corporation, which gives it some unique tax advantages.

“If we didn’t have those advantages, our ability to withstand the Great Recession in 2008-2009 would have been very different because we wouldn’t have had that accumulated capital,” Kadow says.

Now that the economy has recovered, the ESOP is helping Somerville Inc. with another challenge: employee recruitment and retention. That’s especially important as, according to Kadow, fewer young people are pursuing architecture and engineering degrees and senior staff are reaching retirement. The average tenure of Somerville Inc. employees is 13 years, and many employees are hired early in their careers and stay until retirement.

Each year, an independent company assesses the firm’s value and issues updated stock certificates to let employees know how much their shares are worth.

“It’s become a significant retention and recruitment factor because many architecture and engineering firms remain closely held and don’t offer stock to new hires like we do,” Kadow says.

Offering two retirement plans

It’s becoming increasingly important for firms like Somerville Inc. to retain employees as long as possible. The architecture and engineering fields are full of senior-level baby boomers who have amassed a significant amount of expertise and skill. In the next few years, Somerville Inc. expects several of its boomers to retire, so it wants to minimize additional turnover. It also wants to recruit the brightest and best young staff to replenish lost talent.

The fact that an ESOP is essentially a retirement plan, helps. Somerville Inc. now has both a 401K plan and the ESOP.

ESOPs, like 401Ks, are governed by the Employee Retirement Income Security Act (ERISA) of 1974. When employees retire, their stock equity in the firm is paid out over a five-year period. If they leave for any other reason, they must wait five years before their five-year payout period begins.

“Essentially, it’s a cyclical thing where, as people leave the firm, the stock comes back and the current employees receive those shares, their stock in turn builds up as they age, then they retire and the shares go back into the firm again,” Kadow says.

Finding its sweet spot

That’s led to a mind shift. “Employees don’t just view themselves as employees anymore,” he says. “They view themselves as owners.”

Employees are engaged and commitment is high, he says; they are proud to be Somerville Inc. employee-owners.

When employees began to realize the benefits the ESOP model held for them, new committees started to “bubble up” from the mid-level. Those include a quality control committee that assesses completed projects to look for aspects that can be improved, a revenue and profit committee that analyzes labor hours to see how that labor can be used more efficiently, and a software committee that is constantly looking for technology that can increase efficiencies.

“That was a paradigm shift for us in that we gave more power to our employees to make positive change within the firm, and that’s paying big dividends now,” Kadow says. “The pride and ownership employees feel in their work is evident in every project.”

Clients seem to be pleased with these changes as well.

“We’re looking for that sweet spot where we can give the client the best service and value while, at the same time, increase the value of the firm, along with the value of each employee’s share of ownership,” Kadow says. “This is creating an engaging, rewarding environment for the employee-owners of Somerville Inc.”